Should You Like Haidilao International Holding Ltd.’s (HKG:6862) High Return On Capital Employed?

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Today we are going to look at Haidilao International Holding Ltd. (HKG:6862) to see whether it might be an attractive investment prospect. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.

First up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that 'one dollar invested in the company generates value of more than one dollar'.

So, How Do We Calculate ROCE?

Analysts use this formula to calculate return on capital employed:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

Or for Haidilao International Holding:

0.27 = CN¥2.3b ÷ (CN¥12b - CN¥3.3b) (Based on the trailing twelve months to December 2018.)

So, Haidilao International Holding has an ROCE of 27%.

See our latest analysis for Haidilao International Holding

Does Haidilao International Holding Have A Good ROCE?

One way to assess ROCE is to compare similar companies. Haidilao International Holding's ROCE appears to be substantially greater than the 5.9% average in the Hospitality industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of the industry comparison, in absolute terms, Haidilao International Holding's ROCE currently appears to be excellent.

Haidilao International Holding's current ROCE of 27% is lower than its ROCE in the past, which was 48%, 3 years ago. This makes us wonder if the business is facing new challenges. You can see in the image below how Haidilao International Holding's ROCE compares to its industry. Click to see more on past growth.

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is only a point-in-time measure. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

What Are Current Liabilities, And How Do They Affect Haidilao International Holding's ROCE?

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Haidilao International Holding has total assets of CN¥12b and current liabilities of CN¥3.3b. As a result, its current liabilities are equal to approximately 28% of its total assets. The fairly low level of current liabilities won't have much impact on the already great ROCE.

The Bottom Line On Haidilao International Holding's ROCE

This is good to see, and with such a high ROCE, Haidilao International Holding may be worth a closer look. There might be better investments than Haidilao International Holding out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.

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We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.